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April 26, 2013

Who Pays the Bill for Terrorism?

The financial cost of terror must be borne by property owners, insurance companies or taxpayers

Beyond the unfathomable evil perpetrated on April 15 in Boston—human losses that can never be measured—come the more mundane, quantifiable aspects of the mayhem of which the Tsarnaev brothers are suspected.

News reports that the generosity of a taxpayer-financed state welfare program was supporting at least one of the brothers for years is just one facet of the financial picture, but there is another far more diffuse angle that affects Americans nationwide: that is the financial risk that recurring acts of terror pose to the lives, property and businesses of ordinary Americans.

The businesses near the site of the Boston Marathon terror attack were mostly small shops and restaurants that lack terrorism insurance, a new category of coverage stemming from the 9/11 attacks.

Prior to 9/11, terror-caused property damage would have been covered without specific customer costs. But the destruction in New York alone added up in the tens of billions of dollars, leading insurers to exclude the effects of terror from their coverage.

To avoid wider economic losses after 9/11, Congress stepped in with a law—the Terrorism Risk Insurance Act of 2002—that would limit insurance company losses in the event of an act of terrorism involving high losses.

Under the law, which has since been renewed and expires at the end of next year—foreign terror attacks costing under $100 million are paid entirely by insurance companies; a financial hit over that threshold but under $27.5 billion means the government pays and is reimbursed over time by insurance companies, whereas a terror attack involving aggregate losses of $27.5 billion the Secretary of the Treasury has discretion to seek or wave recovery of its payment for losses.

There are other details, including deductibles and cost-sharing, but the basic idea is that the government—meaning the taxpayers—are bearing the financial risk of massive terrorism.

Advocates of TRIA, which include insurance executives such as Ace Ltd.’s Evan Greenberg, say government involvement in a reinsurance role is necessary or else insurers would not take the risk and businesses could not obtain terror insurance.

Indeed, terror coverage was largely unavailable for the year following 9/11 until passage of TRIA, according to a Congressional Research Service study of the terror insurance market published in February.

That report cites Marsh, a large insurance broker, reporting that 65% of its clients in 2011, up from just 27% in 2003, have adopted terrorism coverage, and insurance broker Aon reports that cost of the coverage has consequently come down to 3% or 4% of premiums, down from a high of greater than 7%.

Other voices, such as the Consumer Federation of America, have argued that insurance companies, not taxpayers, should be on the hook for terror risk.

A CFA spokesman is quoted by Insurance Journal in February, saying, “The fact that insurers do not take financial risk for either flood or terrorism insurance is a huge policy error. Taxpayers are required to pick up huge risks that private insurers are more than capable of identifying and backing.”

Wharton School of Business professor Erwann Michel-Kerjan gave what was perhaps a middle position, and a prescient one seven months before the terror attack in Boston.

In testimony before Congress given last year on the 11th anniversary of 9/11, the Wharton insurance expert stated:

“Can the market operate in the absence of a federal backstop…? Yes, but there is likely to be a rather thin market…Could this be sustainable? If there is no successful terrorist act on U.S. soil in the next 10 or 20 years, then yes. But when the next attack occurs, experience shows that Congress will be called to the rescue by businesses that went uninsured…”

Indeed, the shops, bars and other mainly retail businesses in Boston’s fashionable Back Bay, site of the terror attack, were mostly uninsured, according to a recent Wall Street Journal report. They’re hoping the government does not officially declare the events of April 15 an act of terror, which could enable insurance companies to withhold payment for damage under business owners’ general property and casualty coverage.

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